| GaveKal | Published: August 28 2006 18:48:16 |
| The Myth of Reverting margins and Why We Love US Equities | |
| By Daily Newsletter | |
| Louis’ recent Ad Hoc Comment, The Invisible Hand’s Impressive Work, drew a number of questions from clients. Some wondered whether, as we claimed, margins did “always return to the mean”? Could we prove that assertion? Or were we doing nothing more than lazily repeating the average consensus view? These were important questions. After all, If profit margins have peaked in the US, what is the appropriate value to put on those profits? What is the appropriate multiple to pay for stocks? Late-cycle, peak earnings are never accorded a large premium multiple because investors cannot reasonably discount the prevailing profit margin to continue indefinitely… As often with important questions, our initial digging triggered a new batch of questions rather than answers. Namely: 1) how do we define corporate profits, 2) how do profits margins relate to economic growth, 3) how do profit margins relate to consumption, 4) Are the drivers of profit margins cyclical? Or structural? Facing all these questions, we were tempted to just give up, and go to the beach (especially in August). But Steve Vannelli decided to rise to the challenge and break down the US economic data. The result is the following pages which - very frankly - non-aficionados of economic statistics might find a bit mind-numbing. Though the conclusion is not: US equities are poised to generate great returns for their shareholders in the coming years.... |
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